Moneyball without the ball

Posts from the ‘Liqtech (LIQT)’ Category

I wrote a couple of lengthy responses in the comment section that I have reproduced here. One was on RumbleOn (here). The other was about Liqtech (here). I also comment on Smith-Micro and Vicor briefly.

Liqtech

1. Isn’t the installation of scrubbers self-defeating if too many ships continue to use HSFO?

A couple points. First, assuming that there is a point where its self defeating to install scrubbers (which I am going to raise a question about in a second) I believe that its far enough away that if it happens Liqtech will have benefited well beyond what is justified by the current share price. Consider that right now we are talking a couple thousand ships getting scrubbers out of a 70k fleet. And my numbers are assuming Liqtech only gets a fraction of those ships (ie. I don’t have the latest framework agreement modeled in there, I don’t have direct to shipowner sales, no sales from the other 4 scrubber manufacturers they are working with). Second, are we sure it would be self-defeating? Consider this – What are current HSFO to LSFO equivalent spreads (you have to use a gasoil equivalent for LSFO because there isn’t a true LSFO right now) and what would be the payback on scrubbers at those spreads? I was looking at this a month ago and thinking that at current spreads (so right now, with all ships still using HSFO) scrubber payback would still be pretty good. Isn’t this the worst case scenario for spreads after 2020? To put it another way, the reason ships aren’t installing scrubbers right isn’t because spreads aren’t favorable, its because they don’t have to.

2. What is a fair multiple for Liqtech given that their growth is concentrated on the next seven years and will massively flatten or even be negative thereafter?

While it’s hard to predict that far out in the future, there are opportunities that could result in significant earnings even after the retrofit opportunity has passed. First there is the new build opportunity – 60% of new builds are being installed with scrubbers. 1,000-1,500 ships a year get built I believe (I’ve never been able to pin that number down exactly, its always given on a DMT basis, not ship basis) and Liqtech is dealing with 7 of the 10 largest scrubber manufacturers. So the opportunity is quite large.

Second, I think the upside from the ramp could far exceed the current share price on its own. While its tough to project because we don’t know yet whether Liqtech will hold its market share through the build, how many scrubbers will be closed-loop or hybrid, etc, if an optimistic scenario holds then the cash they taken in should exceed the existing share price by quite a bit.

Further off there are other verticals where the exposure from being used in a large number of ships will help give them credibility to expand into – such as scrubbers for power industry, oil and gas flowback filtering, and maybe further inroads into DPFs.

But the main answer i that I think the new build opp is going to be large. The bigger question is what does the regulatory regime look like in 7 years and have even stricter environmental regs come in and how do scrubbers fit into that. And the other obvious big question is whether there are more hiccups in the implementation of the regulations between now and 2020.

3. Will we see lower revenue because the latest framework agreement is for lower ASP systems?

No, I don’t think that’s right. Consider that the new framework agreement is entirely incremental to my model. You can basically add 80-100 units at $230K and 70% margin (they said higher margin and we know existing units at scale are 65% with the Mark 6 design so 70% is my guess). So I think my numbers actually change pretty dramatically for the better with the new agreement. Also consider that the number in my model (80) is actually less than the other two framework agreements. I conservatively said 80 but if you read the transcripts Liqtech said they expect 120 from these two framework agreements.

4. How likely is another capital raise?

Liqtech came out last week and said they don’t need to raise capital this week. They said they had more cash then they had at the end of the second quarter. And soon they are going to be getting a tonne of cash from orders. I agree $4 million doesn’t seem like a lot but given their comments it would definitely be a surprise to me if they raised at this point.

What I think of the IMO 2020 meetings

This wasn’t a question but I had commented last weekend about IMO 2020 here. This is obviously the big weight on the share price. I think the upside based on what can happen is a pretty clear picture. It’s what will happen that was thrown a curveball when the US threw its hat in the ring leading up to the MEPC meetings. But since that time the IMO approved the fuel carriage ban and basically told the flag states that if you want us to consider a proposal for a more gradual approach we want to see more details. So the result was constructive for Liqtech.

The risk remains, but in my opinion the risk specific to Liqtech falls as time passes. The implementation of the fuel carriage ban was the last step for enforcement and that was passed. The rebuke of the flag state proposal says to me that the IMO wants any proposal to clearly state that they are asking only for waivers when compliant fuel is not available and not looking to delay enforcement generally. While the clarification comment that the flag states made leading up to the meetings (which I mentioned in my previous comment) said as much, the actual proposal being voted on last week (which was what the flag states wrote at the end of August and had been interpreted by some as “an attempted coup”) sounded like it was more vague. I don’t think the IMO wants to implement a vague proposal that might open other doors. So they closed the door on that.

At this point the IMO meets next May. That meeting might have a clearer proposal for waivers on the table but I think it’s less likely that some sweeping change comes out of the blue and derails the whole thing. Barring an unforeseen event in the interim, shipowners are going to have to move forward with what they know. I think this means scrubber purchases move ahead.

RumbleOn

I was initially skeptical about the deal. RumbleOn’s third quarter numbers, on the surface, weren’t very good. The reulsts matched what I had suspected when I was watching inventory on a daily basis – in September the numbers flattened out/turned down. As a consequence they missed the unit number. I was surprised that ASP was down too. So when I saw the acquisition my first reaction was: hmmm, are they just trying to paper over a bad quarter and slipping growth?

But since then I’ve listened to the conference call a few times, read through all the documentation and I’m coming around to the deal. The quarter was still not very good though.

Let’s talk about the quarter first.

While the third quarter results and guide are disappointing I’m not sure that they are as bad as they appear at first glance. If you take management at their word, they changed their acceptance criteria for making cash offers, basically limiting offers to cases where they thought they could make at least $1,000/bike. Their “terminated” offers (meaning offers that they didn’t decide to make after the seller went through the trouble) went up from 2% to 15%, which is a big increase. They said this resulted in a 700 bike slip in inventory. That slowed unit sales, which is what I saw on the site myself.

Now you can believe them or not here. Maybe this is an excuse and the business just slowed. But what I have seen on the site is consistent with higher margin bikes being available. They said that their ASP has been much higher in Q4 (anecdotally I saw that too at the end of quarter – that ASP of inventory has definitely gone up).

Maybe the bigger negative about the quarter is that the SG&A as a percentage of revenue did not come down. It was up a little from the second quarter. I had been hoping it would come down soon as the company moved towards profitability. But this didn’t happen, which is a negative.

When I look at the Wholesale acquisition, I understand why the market was lukewarm to it. Wholesale gross margins are tiny, like 4.3%, so even with the volumes (they are expected to sell 2,000 cars a month next year) and even growing 15-20% that’s tough. Carvana has double the margins and the story there is margin expansion as they layer on services. But Wholesale can’t really layer on services because they are selling wholesale, not to consumers.

Therefore on the surface the acquisition kind of looks not that great. What you can say is that it wasn’t expensive (as one analyst on the call pointed out they are getting the business at 12x income and asked why the owners would sell so low).

So that was my first take. But I’m more constructive as I’ve thought about it some more. Here’s how I’m thinking about it now:

How much would it take RumbleOn to create a platform and distribution network to populate their new car and truck online portal with 2,000 vehicles available to consumers from the go, ramp their sales to dealer/auction up to 20,000 per quarter (which is the current Wholesale run rate), building out that network in the process, and build a distribution network to manage the supply chain? I don’t know that number but I think its higher than $23 million.

For $23 million they get immediate inventory that can go to the soon-to-be launched consumer facing site, they get a built and operating distribution network for deliveries and dealer network, and they get to layer on their consumer cash offer business. And yes they also get the dealer purchasing vertical that Wholesale excels at as well as a couple of retail locations.

Yes margins at Wholesale are really low, but it’s because they buy from dealers, refurbish and sell to auction/dealer. Wholesale seems to me to be essentially an arbiter. But I don’t think RumbleOn bought Wholesale because they were enamored with this dealer to dealer business.

To put it another way, Wholesale also has an existing network and inventory that can be leveraged to more quickly build the higher margin consumer purchases and higher margin consumer sales that RumbleOn has always planned. RumbleOn has the automated cash offer system to drive consumer purchases which will be better margins. They have their site/app/brand to drive consumer sales.

I think that looking at Wholesale’s business as-is or trying to think about how RumbleOn will improve Wholesale’s existing business is probably not paramount to how Chesrown and Berrard are thinking about it – yes, RumbleOn should be able to make incremental improvements on what Wholesale does through data analysis that improve decisions but that’s not the primary motive for the acqusition – the point is layering on the consumer online buy side with the cash offer model and consumer sales through the website, and leveraging Wholesale’s existing dealer network to maximize turns right from the start. Improvements to Wholesale’s existing business are peripheral to what they are really going for here in my opinion.

They said it multiple times on the call – RumbleOn is creating a supply side solution – they are demand side agnostic – consumer/dealer/auction – whatever. They need to be able to access each vertical and the more they can sell to consumer the better but unlike Carvana, Vroom, et al the focus is not sales to consumers. Its closer to the other way around – the focus is buying from consumers. They will sell whereever they can sell fastest to maximize turns. It’s the buy side that matter, procuring as much inventory from as possible from consumers while insuring it’s the right vehicle at the right price. If they get the buy side right the sell side sorts itself out. Wholesale fits nicely into this IMO.

So I like the acquisition. But I also think the logic behind it is complicated and I’m not totally sure the market will agree with me right away. I also think the quarter was not so good and you have to buy into management’s explanation to be okay with the results. So we may get more pain. Nevertheless, I did buy back a position on Friday.

A couple other things

I bought back Smith-Micro after the earnings report. I had said in my update that I was worried they would miss estimates. They did, kind of. I could have sworn the Roth estimate (the only analyst) was $6.7 million of revenue for the quarter. The company came in at $6.5 million. But when I looked after earnings it appears the estimate was actually $6.1 million. So I don’t know if I imagined that $6.7 million number or whether Roth changed it at the last minute.

For what its worth it means they beat, but the stock fell anyway. I didn’t think it was a bad quarter at all though. Safe & Found adoption at Sprint continues at a steady pace, there are overtures of a second carrier in the next 6-9 months, and it appears that the sunset of the legacy product used by Sprint customers is coming. These are all positives and really the only negative had to do with the peripheral Graphics business, which saw a steep revenue decline but is now at the point where it can’t hurt the company going forward. So I bought.

Vicor stock action remains a gong-show. I’m holding on (pretty much HODL at this point) and I did think their quarter was fine. There is weakness in the legacy business but the new products bookings were up 20% sequentially, which is a great number. Apparently there is a negative report or article on Vicor that has been out for a while that could be the basis for some short selling of the stock. John Dillon mentioned it on SeekingAlpha. If anyone has the report I’d really appreciate seeing it.

Portfolio Performance

Thoughts and Review

I haven’t written a post since my last portfolio update. Up until this last week I did not add a new stock to my portfolio. I have sold some stocks though. Quite a few stocks really.

I have been cautious all year and this has been painful to my portfolio. While the market has risen my portfolio has lagged. I have lagged even more in my actual portfolio, where I have had index shorts on to hedge my position and those have done miserably until the last couple of weeks. In fact these last couple of weeks are the first in some time where I actually did better than the market.

My concerns this year have been about two headwinds. Quantitative tightening and trade.

Maybe its being a Canadian that has made me particularly nervous about the consequences of Trump’s protectionism. With NAFTA resolved I don’t have to worry as much about the local consequences. But I still worry about how the broad protectionist agenda will evolve.

I continue to think that the trade war between the United States and China will not resolve itself without more pain. The US leadership does not strike me as one open to compromise. Consider the following observations:

Peter Navarro has written 3 books about China. One is called “Death by China”, another is called “Crouching Tiger: What China’s Militarism Means for the World” and the third is called “The Coming China Wars”.

In the Amazon description of Death by China it says: “China’s emboldened military is racing towards head-on confrontation with the U.S”. In the later book, Crouching Tiger, the description says “the book stresses the importance of maintaining US military strength and preparedness and strengthening alliances, while warning against a complacent optimism that relies on economic engagement, negotiations, and nuclear deterrence to ensure peace.”. The Coming China Wars, his earliest book (written in 2008), notes “China’s dramatic military expansion and the rising threat of a “hot war”.

Here’s another example. Mike Pence spoke about China relations last week at the Hudson Institute. Listening to the speech, it appeared to me to be much more about military advances and the military threat that China poses than about trade. The trade issues are discussed in the context of how they have led to China’s rise, with particular emphasis on their military expansion.

John Bolton’s comments on China are always among the most hawkish. Most recently he spoke about China on a radio talk show. Trade was part of what he said, but he focused as much if not more on the Chinese behavior in the South China Sea and how the time is now to stand up to them along those borders.

Honestly when I listen to the rhetoric I have to wonder: Are we sure this is actually about trade?

Is it any coincidence that what the US is asking for is somewhat vague? Reduce the trade deficit. Open up Chinese markets. Less forced technology transfer (ie. theft). Now currency devaluation is part of the discussion.

I hope that this is just a ramp up in rhetoric like what we saw with Canada and Mexico. That the US is trying to assert a negotiating position before going to the table and reaching some sort of benign arrangement. But I’m not convinced that’s all that is going on.

If this has more to do with pushing China to the brink, then that’s not going to be good for stocks.

I can’t see China backing down.

From what I’ve read China can’t possibly reduce the trade deficit by $200 billion as the US wants without creating a major disruption in their economy. Never mind the credibility they would lose in the face of their own population.

Meanwhile quantitative tightening continues, which is a whole other subject that gives me even more pause for concern, especially among the tiny little liquidity driven micro-caps that I like to invest in.

I hope this all ends well. But I just don’t like how this feels to me. I don’t want to own too many stocks right now. And I’m not just saying that because of last week. I have been positioned conservatively for months. It’s hurt my performance. But I don’t feel comfortable changing tact here.

Here’s what I sold, a few comments on what I’ve held, and a mention of the two stocks I bought.

What I sold

I don’t know if I would have sold RumbleOn if I hadn’t been so concerned about the market. I still think that in the medium term the stock does well. But it was $10+, having already shown the propensity to dip dramatically and suddenly (it had fallen from $10 to $8 in September once already), and having noted that Carvana had already rolled over in early September, I decided to bail at least for the time being. Finally there was site inventory turnover, which if you watch daily appeared to have slowed since mid-September. Add all those things up and it just didn’t feel like something I wanted to hold through earnings.

I was late selling Precision Therapeutics because I was on vacation and didn’t actually read the 10-Q until mid-September. That cost me about 20% on the stock. I wrote a little about this in the comment section but here is what has happened in my opinion. On August 14th the company filed its 10-Q. In the 10-Q on page 14 it appears to me to say that note conversion of the Helomics debt will result in 23.7 million shares of Precision stock being issued. This is pretty different than the June 28th press release, where it said that the $7.6 million in Helomics promissory notes would be exchanged with $1 shares. Coincidentally (or not) the stock began to sell off since pretty much that day.

Now I don’t know if I’m just not reading the 10-Q right. Maybe I don’t understand the language. But this spooked me. It didn’t help that I emailed both IR and Carl Schwartz directly and never heard back. So I decided that A. I don’t know what is going here, B. the terms seemed to have changed and C. it’s not for the better. So I’m out.

I decided to sell R1 RCM after digging back into the financial model. I came to the conclusion that this is just not a stock I want to hold through a market downturn. You have to remember there is a lot of convertible stock because of the deal they made with Ascension. After you account for the conversion of the convertible debt and all the warrants outstanding there are about 250 million shares outstanding. At $9.30, where I sold it, that means the EV is about $2.33 billion. When I ran the numbers on their 2020 forecast, assuming $1.25 billion of revenue, 25% gross margins, $100 million SG&A, which is all pretty optimistic, I see EBITDA of $270 million. Their own forecast was $225 – $250 million of EBITDA. That means the stock trades at about 9x EV/EBITDA. That’s not super expensive, but its also not the cheapie it was when I liked the stock at $3 or $4. I have always had some reservations about whether they can actually realize the numbers they are projecting – after all this is a business where they first have to win the business from the hospitals (which they have been very successful at over the last year or so) but then they have to actually turn around the expenses and revenue management at the hospital well enough to be able to make money on it. They weren’t completely-successful at doing that in their prior incarnation. Anyways, I didn’t like the risk, especially in this market so I sold. Note that this is an example of me forgetting to sell a stock in my online tracking portfolio so it still shows that I am holding it in the position list below. I dumped it this week (unfortunately at a lower price!).

I already talked a bit about my struggle and then sale of Aehr Test Systems in the comment section. I didn’t want to be long the stock going into the fourth quarter report. Aehr is pretty transparent. They press release all their big deals. That they hadn’t announced much from July to September and that made it reasonably likely that the quarter would be bad. It was and the stock felll. Now it’s come back. It was actually kind of tempting under $2 but buying semi-equipment in this market makes me a bit nervous so I didn’t bite. Take a look at Ichor and how awful this stock has been. Aehr is a bit different because they are new technology that really isn’t entrenched enough to be in the cycle yet. Nevertheless if they don’t see some orders its not the kind of market that will give them the benefit of the doubt.

BlueLinx. I don’t have a lot to say here. I’m not really sure what I was thinking when I bought this stock in the first place. Owning a building product distributor when it looks like the housing market is rolling over was not one of my finer moments. I sold in late August, then decided to buy it in late September for “an oversold bounce”. Famous last words and I lost a few dollars more. I’m out again, this time for good.

When I bought Overstock back in July I knew I was going to A. keep the position very small and B. have it on a very short leash. I stuck with it when it broke $30 but when it got down to $28 I wasn’t going to hang around. Look, the thing here is that who really knows? Maybe its on the verge of something great? Maybe its a big hoax? Who knows? More than anything else what I liked when I bought it was that it was on the lower end of what was being priced in and the investment from GSR showed some confidence. But with nothing really tangible since then it’s hard to argue with crappy price action in a market that I thought was going to get crappier. So I took my loss and sold.

Thus ends my long and tumultuous relationship with Radcom. I had sold some Radcom in mid-August before my last update primarily because I didn’t like that the stock could never seem to move up and also because I was worried about the second quarter comments and what would happen to the AT&T contract in 2019. I kept the rest but I wish I would have sold it all. In retrospect the stocks behavior was the biggest warning sign. The fact that it couldn’t rise while all cloud/SAAS/networking stocks were having a great time of it was the canary in the coal mine. As soon as the company announced that they were seeing order deferral I sold the rest. I was really quite lucky that for some reason the stock actually went back up above $13 after the news (having fallen some $4-$5 the day before mind you), which let me get out with a somewhat smaller loss. The lesson here is that network equipment providers to telcos are crummy stocks to own.

Finally, I sold Smith Micro. This is a second example where I actually didn’t sell this in the online portfolio until Monday because I didn’t realize I had forgotten to sell it until I put together the portfolio update. But it’s gone now. I wrote a little about this one in the comment section as well. The thing that has nagged me is that the second quarter results weren’t really driven by the Safe & Found app. It was the other products that drove things. That worries me. Again if it wasn’t such a crappy market I’d be more inclined to hold this into earnings and see what they have to say. They could blow everyone away. The stock has actually held up pretty well, which might be saying that. Anyways I’ll wait till the quarter and if it looks super rosy I’ll consider getting back in even if it is at a higher price.

What I held

So I wrote this update Monday and Vicor was supposed to report Thursday. Vicor surprised me (and the market I think) by reporting last night. I’m not going to re-write this, so consider these comments in light of the earnings release.

One stock I want to talk about here is Vicor, which I actually added to in the last few weeks. Vicor has just been terrible since late August. The stock is down 40%. I had a lot of gains wiped out. Nevertheless this is one I’m holding onto.

I listened to the second quarter conference call a couple of more times. It was really quite bullish. In this note from Stifel they mention that Intel Xeon processor shipments were up significantly in the first 4 weeks of the third quarter compared to the second quarter. They also mention automotive, AI, cloud data centers and edge computing as secular trends that are babies being thrown out with the bath. These are the areas where Vicor is growing right now (Vicor described their core areas on the last call as being: “AI applications including cloud computing, autonomous driving, 5G mobility, and robots”).

Vicor just started shipping their MCM solutions for power on package applications with high ampere GPUs in the second quarter. They had record volume for some of their 48V to point of load products that go to 48V data center build outs and a broader acceptance by data center players to embrace a 48V data center. There’s an emerging area of AC-DC conversion from an AC source to a 48V bus. John Dillon, who is a bit of a guru on Vicor, wrote a SeekingAlpha piece on them today.

I know the stock isn’t particularly cheap on backward looking measures. But its not that expensive if the recent growth can be extrapolated. I’m on the mind it can. Vicor reports on Thursday. So I’ll know soon enough.

The second stock I added to was Liqtech. I’ve done a lot of work on the IMO 2020 regulation change and I think Liqtech is extremely well positioned for it. When the company announced that they had secured a framework agreement with another large scrubber manufacturers and the stock subsequently sold off to the $1.50s, I added to my position.

I’m confident that the new agreement they signed was with Wartsila. Apart from Wartsila being the largest scrubber manufacturer, what makes this agreement particularly bullish is that Wartsila makes its own centrifuges. Centrifuges are the competition to Liqtech’s silicon carbide filter. If Wartsila is willing to hitch their wagon to Liqtech, it tells me that CEO Sune Matheson is not just tooting his horn when he says that Liqtech has the superior product. I’ve already gone through the numbers of what the potential is for Liqtech in this post. The deal with Wartsila only makes it more likely that they hit or even exceed these expectations.

Last Thought

I took tiny positions in three stocks. One is a small electric motor and compressor manufacturer called UQM Technologies. The second is a shipping company called Grindrod (there is a SeekingAlpha article on them here). The third is Advantage Oil and Gas. All of these positions are extremely small (<1%). If I decide to stick with any of them I will write more details later.

Portfolio Composition

I owe this idea to @teamonfuego. He brought it up to me a couple weeks ago. Unfortunately, I was on vacation and I was slow to the punch. As it was I ended up picking up the stock at $1.10 on average.

Liqtech has been your typical little energy technology company. They have an interesting technology but have struggled to sell it into established markets that aren’t all that interested in new ideas.

The consequence is that the stock has spent years bouncing around with no real upward momentum, every year losing money and raising capital.

What they sell

Liqtech sells a suite of silicon carbide filter products. They’ve tried to break into oil and gas, into mining, even into pools and spas. But they’ve only had moderate luck. They have a small but fairly steady business selling diesel particulate filters (around $8 million a year of revenue). Beyond that they sell a few filter systems a year but never enough to break-even on a consistent basis.

From what I can gather, their lack of success is not because of the product. The silicon carbide filter is a better product for many industrial waste/purification applications than what is used right now. But that doesn’t always guarantee a win.

The problem has been getting a foot in the door. This article, from way back in 2014 with CEO Sune Mathiesen, describes the problem that the company has had in the past:

My initial, and most important focus point was to turn the Company around from being a supplier of membranes into a supplier of complete water treatment systems. Since LiqTech started commercializing its membranes in 2009, it has proven very difficult to convince system integrators to invest time and money in developing systems around our membrane technology. The reason is simple, most engineers know how to build a system around sand filters, polymer membranes or other well-known technologies, but they don’t know how to handle our silicon carbide products.

Beginning in 2015 Mathiesen made the transition from selling membranes to selling filter systems. They began to research and invest in building a full filter assembly so they could by-pass the system integrators.

Three years has passed and the stock hasn’t exactly lit the world on fire. But they’ve been slowly built out a product line of filter systems for various applications. And now one of those applications appears about to take off.

IMO 2020

IMO 2020 refers to new regulations from the International Marine Organization that come into effect in 2020. These regulations change the pollutant requirements of bunker fuel, reducing the maximum SO2 concentration in marine fuel exhaust from 3.5% to 0.5%.

About 60-70% of the shipping fleet uses a bunker fuel that has >0.5% SO2. The most common bunker fuel has SO2 of about 2.7%. The ships that use this fuel will have to do something about that by 2020.

The ship owners don’t have many choices. They can either switch to a more expensive low sulphur fuel or install scrubbers that clean out the SO2 from the high-sulphur bunker fuel.

The economics around fuel switching versus scrubbers is in favor of the scrubbers. Here’s a quote from Rudy Kassinger, consultant at Veritas Petroleum Services, from this article:

The cost of installing scrubbers is somewhere between $3 million and $6 million depending on the ship (though I have seen estimates that use a high-end number as much as $10 million). The payback on scrubbers can be 1-3 years. Most of the articles I’ve read peg the number at 2 years, which is not too bad.

So how does this impact Liqtech?

Liqtech filters are installed as part of the scrubber assembly.

Scrubbers can operate in open loop, closed loop or hybrid configurations. When a scrubber operates in an open-loop, sea water is used to remove pollutant from the exhaust stream. The sea water is then discharged back into the ocean.

But in harbors and in some regulated waters seawater discharge is not possible. In these areas a closed loop or hybrid system needs to be used where no polluted water is discharged.

The closed loop requires that the effluent water be filtered for re-use. This is where Liqtech filter systems come in. The silicon carbide filter is ideal for the application (in terms of durability, temperature resistance, corrosion and operating performance).

The opportunity for Liqtech is large. Each scrubber installation needs a filter. Ships require on average 1.6 scrubbers (so some need 1, some need 2). The shipping fleet is about 70,000 vessels. Some percentage of those ships will be retrofitted for filters. As well more new builds will include scrubbers going forward.

According to Goldman Sachs less than 500 ships have scrubbers installed today. Goldman estimates that by 2025 we should expect to see over 5,000 ships equipped with scrubbers. Other estimates are even higher. The IMO put out its own estimate (quoted in this WSJ article) forecasting 4,000 ships with scrubbers by the end of 2020. Liqtech said on their second quarter call that:

Analysts believe that by 2025 roughly 14,000 vessels are roughly 20% of the global fleet with have a scrubber.

Whatever the number, its meaningful to Liqtech. Liqtech sells the marine scrubber filters for about $450,000 a unit. At 1 scrubber per ship, the total addressable market is somewhere between $1.8 billion and $6.3 billion.

Liqtech has 72.7 million shares outstanding and no debt. So even after the latest run, its only a $87 million market capitalization company. The addressable market is truly multiples of the capitalization.

The obvious question is what sort of market share can they capture? Things look pretty good so far.

In March they announced a framework agreement with “one of the world‘s largest manufacturers of marine scrubbers” for “an initial term for 2018 and 2019 and provides that more than 95 systems are estimated to be delivered”

In April they announced a second framework agreement for “a minimum of 35 systems are estimated to be delivered during the initial term” of 2018 and 2019.

Also in April they announced a letter of intent with “one of the world’s largest marine scrubber manufacturers”. This was extended in July. On the second quarter call they said the LOI was for 95+ systems.

On the first quarter call Liqtech said they were working with five or six of the largest scrubber manufacturers. They said on the second quarter call that they are expecting to see orders coming from other sources as well:

we believe that we see a lot of the orders in the future come directly from the shipyard operators. It doesn’t necessarily mean that — or it doesn’t mean that we’ll not see orders coming from scrubber manufacturers, it just means that I have told to several sources for orders in the future.

I’d make a guess that the 95 system framework agreement is with Yara, which is a large scrubber manufacturer. Liqtech has previously disclosed they have been working with Yara. A look at this Yara video shows a filter that looks pretty much the same as what Liqtech shows in their own presentation.

I’m not sure who the other 35 systems or the LOI are with. The list of scrubber manufacturers includes: Alfa Laval, Wartsila, Saacke, Yara, Puyier, DuPont, and Feen Marine. Liqtech has said there are 10 major manufacturers in total.

So what kind of impact is this going to have on the bottom line?

I think its going to be significant. Here are a few points to consider.

The company says their break-even is $16-$18 million of revenue, on the sale of about ~20 filters systems for marine scrubbers

On the second quarter call they said incremental systems sold should expect 70-75% gross margins and they have also said they expect 65% contribution margin from incremental sales

The current expense run rate is $1.25 million per quarter

There are $14 million of NOLs in the US and another $6 million in Denmark

I’m assuming they need to sell about 20 systems in 2019 to hit a break-even point at current run-rates. If the two framework agreements come to fruition they will sell 130 systems, heavily weighted to 2019. Let’s say they sell a total of 80, so 60 that are incremental to the break-even number.

I’m throwing in the 21% tax rate even though they shouldn’t be taxed through most if not all of 2019. Un-taxed EPS is over 23c with these assumptions.

Conclusion

One downside is that sales of filters to the existing marine scrubber fleet is not going to last forever. There are limits on ship-yard capacity which will extend the retrofits out to 2025. But probably some time around then (maybe sooner, maybe later depending on how things play out) the installs will taper off.

There will be continued sales from new-builds after 2025. There are 70,000 ships globally. It seems like for most markets (containerships, dry bulkers, tankers) at least 3% of the fleet is added every year. So that’s ~2,000 ships a year. On the first quarter call Liqtech said they expect to see a further uptick on the 30-40% of new-builds that are currently being built equipped with scrubbers. So the opportunity is not insignificant.

Also, by the time the retrofit opportunity is exhausted, and assuming everything plays out positively, Liqtech will have an install base numbering into the 100’s of ships.

I would expect it will be a lot easier to hock their product to big oil producers, power producers, miners, and municipal water suppliers with a resume that includes a major vertical that has accepted their filters in an extreme environment.

But that’s a long way off. For now, its enough to say that the stock is cheap if they can secure the expected number of deals from the existing framework agreements and have those agreements project forward, and it is very cheap if they can capture even more market share from other scrubber manufacturers and shipyards.

A second risk is that they start to see price pressure. They are the only provider of a silicon carbide filter but there is competition by way of centrifugal filters. Liqtech has said before they are the cheaper and better option. But as the higher volumes are borne out you have to expect competition. The margins I’m showing in the table above are admittedly very high, and unlikely to be sustainable in the long run.

A third risk is that IMO 2020 gets delayed. From everything I’ve read I don’t see this happening. But you never know.

The bigger upside is that they capture a larger share of the market. I’m assuming about 80 filters a year. The opportunity size is significantly larger (as much as 14,000 installs according to Liqtech) next 5 years.

The other upside is that I have to think it will be easier to sell into other verticals once they can come to these customers with a portfolio of installs throughout the marine scrubber industry.

Anyways, it seems like a pretty tiny capitalization for such a big opportunity. Worth a portfolio spot in my opinion.

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